Down to the Wire in the US Debt Crisis
Jul 27, 2011
Posted by Jody Eisenman | Filed under Uncategorized
While Democrats and Republicans continue to fiddle in their Washington sandbox, Wall Street is starting to burn. As we enter the last few days before the August 2 deadline, Obama and congress appear to be no closer to getting a compromise done on raising the nations’ debt ceiling. In a nut shell, Obama and most of the Democrats will agree to substantial spending cuts going forward, as long as it is combined with a tax increase. They also want a deal that will last past the 2012 elections, such that Obama does not need to go through this again prior to his reelection bid. The Republicans want larger cuts without any tax increases. They would be willing to go for some sort of short term plan that would force Obama back to the table before the November 2012 elections. While the rhetoric has been high, it doesn’t appear that the two sides are all that close. What compounds the problem is that some of the hard core left wing Democrats and Tea Party Republicans do not really want to compromise much at all. As such, even though I still believe that they will reach some sort of compromise in the eleventh hour, I think the chance of no deal happening before the August 2 deadline is now higher than ever. It would no longer shock me if there is no deal by that date.
If that were to happen, the effect on the financial markets is uncertain. However, the DJIA has fallen 420 points in the last four trading days, including a drop of almost 200 points today. The VIX (a measure of market volatility) has now moved from around 17.5 to almost 23. This is the highest closing level since March 18. It seems likely that the market will continue to drop absent a deal. Should a default actually occur the effect on foreign purchases of US debt could get ugly quickly. As I have stated many times here, we are a debtor nation, and live off the largesse of investors willing to buy out treasury bonds. Would a default lead foreign buyers to shy away from future purchases, leading to a dramatic spike in interest rates? Let’s hope we don’t have to find out.
